Wednesday, 30 October 2013

EUROPE: Spain out of Recession & The Crisis still on

In August, it was good news for southern Europeans countries when it was confirmed that the Eurozone came out of its long recession in the second quarter of this year- expanding by 0.3 percent.
And today the first green shoots of recovery in the Spanish economy have been officially confirmed. According to the National Office of Statistics, Spain has recorded 0.1 percent growth – the economy’s first expansion in nine quarters.

Strong exports have helped Spain edge into positive ground, though with demand at home still depressed, sustainable growth that creates jobs may remain elusive for years. Compared to labor-heavy sectors such as construction or services, export create few domestic opportunities and with more than one in four out of work, the recovery will ring hollow for many. Unemployment is still stubbornly high and Madrid hopes the jobless rate has already peaked at 26.3 percent.

Although the Eurozone emerged from recession in the second quarter of 2013, with the single currency area’s GDP increasing by 0.3 per cent, ( the situation has improved) , a closer look at the economic data would suggest reason for caution.

The root cause of Europe’s sovereign debt crisis may not have been excessive public spending, but rather a divergence between wages in sheltered sectors (largely in the public sector) and the manufacturing (export) sectors in European economies, which affected states’ external competitiveness. Until this problem is solved any recovery is likely to be short lived.

There’s a lot of talk of the Eurozone crisis abating. In that story, austerity and structural reforms have done their job, current account deficits have been reduced or disappeared altogether, and countries such as Spain are now more competitive than France, while Ireland is ready to go back to the markets and leave the umbrella that the European rescue package offered the country.

Some point out, bitterly, that the collapse of demand in the ‘peripheral’ economies of the Eurozone is the main reason why current accounts have become more balanced, killing off imports, but nonetheless accept that something positive has happened. Link that to the ECB’s policy to do whatever it takes and the permanent rise of the euro against the dollar and the pound – a sign of confidence by international financial markets – and the optimism seems to have firmer roots than the pessimists thought half a year ago.

Things have started to go better for the euro, it is because the euro area’s external position has improved quite substantially: EMU now has a trade surplus of the order of 2.5 per cent of GDP against the rest of the world, and things have moved a bit within the Eurozone on the back of that. But fundamentally not much has changed. The case of Spain.
Competitiveness would improve if two conditions were met: one, if costs in the sheltered sector in Spain (adjusted for productivity) grew at a rate that was considerably slower than in the sector that is exposed to trade; two, if costs, including wages, in the Spanish export sector (shorthand for tradables, ie. exposed) grew, again adjusted for productivity, at a slower pace than those of their main trading partners in the same sectors. And that has not happened, he claims, or at least not enough.

In a recent LEQS paper co-authored with Alison Johnston and Suman Pant from Oregon State University, we analyse, in all EMU member states and a few outside, the divergence in wages (expressed in unit labour cost terms, ie. adjusted for labour productivity) between sheltered sectors (primarily the highly unionised public sector) and the manufacturing (export) sector in the run-up to the crisis of EMU.

Those countries that ended up in serious trouble around 2010 all had a massive divergence between these two wage developments, while the others did not. Where trouble emerged, public sector wage growth translated into a higher aggregate price level, which became a problem for external competitiveness.

The export sector, then, was incapable of controlling wages in the public sector through laws or other forms of coercion, was unable to compensate for inflationary pressures by raising its own productivity while moderating wages, or failed because of institutional weakness, low productivity traps or simply its relatively small size. The result: a collapse in relative competitiveness and a massive current account gap.

EU policymakers say it is premature to say the Eurozone’s crisis is over and call on governments to press on with the painful reforms that can return business dynamism to the bloc, beyond the expected improvement in the third quarter. And if we are right in our understanding of where the roots of the problem lie, then the crisis of the euro is far from over.